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One-Bar Patterns

(This is the fourth in a series of articles on basic technical analysis originally published in Futures magazine.)

Most of the well-known chart formations used by technical analysts require a number of price bars before a pattern can be identified. However, sometimes, only one or two bars can provide a clue to future price action.

Perhaps, the best known or most mentioned of these one-bar patterns is the key reversal. A key reversal down is a price bar that has a high above the previous bar’s high and then reverses to close below the previous bar’s close. A key reversal up is a mirror image -- a bar with a lower low that reverses and closes above the previous day’s close. Typically, a key reversal is interpreted as the market’s attempt to drive to a new high or low, failing to do so and then giving up in exhaustion as prices close lower (key reversal down) or higher (key reversal up).

Daily commentaries often talk about a market making a “key reversal up” or a “downside reversal”, and it usually is made to sound like a significant development. The problem is that the reliability of the key reversal falls into the category of weather forecasts and economic predictions: If you want to be right, forecast early and often.

Like many chart patterns, the value of a key reversal depends on where this pattern occurs on the chart, what happens to prices immediately after it occurs and what the volume looks like on the key reversal bar. When all these things work together, the key reversal can look rather impressive on a chart, but this tends to be more obvious in hindsight, especially if the signal occurs at the end of an extended move. The accompanying chart of Disney shows follow-up prices doing a pretty good job of confirming downside reversals but mixed results for upside reversals -- for every valid signal, there’s another one that doesn’t work.

To improve the track record of the key reversal, some analysts stiffen the requirements. For a key reversal down, the high must be above the previous bar’s high, but the close not only must be below the previous day’s close but also below the previous day’s low. Or, the close must be below the close not just for the previous bar but the closes for a specified number of prior bars. For a key reversal up, the close would have to be above both the previous close and the previous day’s high or above the closes for a multiple number of bars.

The key reversal bar may or may not be an “outside bar” -- that is, the high is above the previous high, and the low is below the previous low so that the range of the current bar is greater than the range of the previous bar. Outside bars typically occur during more volatile, erratic price periods when the market seems to be a little confused about which way it wants to go and tries to run in both directions. Depending on whether the high or low occurs first and on the close, it may indicate the market is trying to make a turn.

Another one-day pattern is the “inside bar” -- the high is below the previous high, and the low is above the previous low. These tend to occur in quieter periods of price consolidation and are sometimes associated with symmetrical triangles when no compelling force has yet been identified that will take the market in either direction.

In these situations, the location of the close may tip off the market’s strength or weakness or its inclination to go in one direction of the other. The trader may want to place stops above or below the bar or may want to bracket the bar with stops both above and below it and wait for followup price action to determine a longer-term position.

Rather than just use the high and low of one bar, sometimes, analysts use the “true high” minus the “true low” to get a bar’s “true range”. The true high is the higher of the current bar’s high or the previous bar’s close; the true low is the lower of the current bar’s low or the previous bar’s close. This provides a smoother representation of highs and lows and a continuous flow of price information when a gap occurs on the chart.

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